While the SEC works on finalizing its proposed Regulation Best Interest, there continues to be significant activity at the state level that will cover, in varying degrees, the same subject matter. The comment period in New Jersey has closed on its preproposal to issue fiduciary standards for broker-dealers and proposed regulations could be issued in the near future. The Investment Transparency Act, initially introduced in 2017, was reintroduced into the New York State Senate this week. The Maryland Financial Consumer Protection Commission this week issued a report recommending that a fiduciary standard be imposed upon broker-dealers and insurance agents. A Maryland State Senator who introduced a fiduciary-duty bill in 2018 has indicated that he intends to re-introduce legislation enacting the Commission’s recommendation.
While the actions in New Jersey, Maryland, and New York are all forthcoming, Nevada last week issued proposed regulations implementing a 2017 Nevada statute. That legislation revised the Nevada Securities Act (the “Act”) to mandate that any “broker-dealer, sales representative, investment adviser, or representative of an investment adviser shall not violate the fiduciary duty owed to a client under Nevada law.” The Act also modified the definition of financial planners to remove an exclusion for broker-dealers and their representatives and investment advisers and their representatives. In addition, the Act gave the Nevada Office of Secretary of State, Insurance Division, authority to define the fiduciary duty by defining certain acts as violations or exclusions from the duty and prescribing means reasonably designed to prevent acts that would violate the fiduciary duty.
On January 18, 2019, the Nevada Securities Division issued these proposed regulations, the comment period for which ends on March 1, 2019. Under the proposed regulations, broker-dealers and investment advisers are subject to a fiduciary duty for the period during which they provide investment advice, perform discretionary trading, maintain assets under management, act in a fiduciary capacity towards the client, disclose fees or gains, through the completion of any contract and through the term of engagement of services. Only broker-dealers are eligible for the Episodic Fiduciary Duty Exemption, which limits fiduciary duty to the specific advice recommended, but would not impose an ongoing fiduciary duty. Broker-dealers who are dually registered as investment advisers are presumed to be investment advisers and, therefore, are not eligible for the Episodic Fiduciary Duty Exemption.
Additionally, the proposed regulations list a series of activities that would constitute a breach of fiduciary duty, but also identify certain actions that would not be treated as a per se breach. The sale of proprietary products by a broker-dealer or sales representative in and of itself would not be a breach of fiduciary duty if certain conditions were satisfied, including advising the client that the product is proprietary and of all of the risks associated with the product. Similarly, transaction-based commissions for sales would not be a breach of fiduciary duty, provided that it is in the client’s best interest to be charged by commission as opposed to other types of fees, and the commission is reasonable. As was the case with the SEC’s proposed Regulation Best Interest, “best interest” is not defined.
The proposed regulations do not contain a carve-out for ERISA plans. The Nevada Securities Division was certainly advised that any state law would be preempted by ERISA and it is likely aware that the absence of an ERISA carve-out in the final regulations will be challenged in court. A reasonable inference is that the Securities Division believes that an ERISA preemption challenge is likely to be unsuccessful – perhaps relying upon the statutory exemption to ERISA preemption for state securities laws, although that is not the sole ERISA preemption issue.
From a securities law perspective, the financial services industry is clearly a supporter of a uniform federal statute rather than the patchwork result of 50 different state laws, and that issue is acknowledged, in part, in the proposed regulations. First, the Securities Division indicated that the proposed regulations should be read “in harmony” with the Securities Exchange Act of 1934 as amended by the National Securities Market Improvement Act of 1996, with respect to recordkeeping requirements. Second, the proposal also authorizes the Securities Division to adopt any rule, form or exemption provided by the SEC for application to broker-dealers, investment advisers, but only so long as the adoption does not materially diminish the fiduciary duty under applicable law. Thus, if the Securities Division, as a practical matter, believes that SEC rules are not as protective of client interests as the Nevada rules, the Nevada rules will continue in effect. It appears that the Securities Division does not believe, or is not ready to concede the point in the absence of litigation, that its proposed regulations are preempted by the Investment Advisers Act of 1940.